Question

At the end of Year 2, the pension benefit obligation for the design team was $4,131,000 and the plan was fully funded (i.e. plan assets were also $4,131,000). They also had no balance in accumulated other comprehensive income for pensions. Because of this, the pension did not appear on Terry’s Year 2 balance sheet. The pension expense and contributions for Year 3 have not yet been recognized.On December 31st, Terry contributed $1,562,000 to management’s 401(k) and $520,506 to the designer’s pension fund. On that same day, Terry received the following information from their actuarial firm:

1) The annual service cost was $99,900

2) The expected return on plan assets was 7.0% and the discount rate on the pension benefit obligation was 6.0%.

3) The actuarial adjustment to the obligation for the year reduced the projected obligation by $39,960.

The plan’s administrator reported that the plan paid out $598,582 in benefits for the year and had an ending asset balance of $4,544,100.

Calculations

1) Calculate each of the three (3) ratios before you make any adjustments.

2) Fill out a pension worksheet for the changes to the defined benefit pension.

3) Make the appropriate journal entries, if any, to account for the pension costs (including any necessary changes to income tax expense). Assume that compensation for the design team is recorded as part of R&D Expense.

4) Make any necessary changes to the financial statements. Please see the hints about the special adjustment to the Statement of Cash Flows.

5) Calculate the three (3) ratios after you make any adjustments

Answer 1

1.Pension funding ratio

The ratio of a pension plan's assets to its liabilities.

= 4,131,000/598,582

=6.90%

Percent Over/(Under)-Funded = (Plan Assets – DBO) / DBO

4,131,000-1,562,000/1,562,000

=1.64

2.Pension Worksheet

Service Cost= $99,900

+Interest Cost=Nil

+Actual Return=247,860

-Contribution=520,526

+Benefits=$598,582

3.Pension Expense -946,342

Cash - 520,526

Pension Asset/Liability - 425,816

4.M ost changes in pension plans result in increases in future benefits. Four alternative methods have been suggested to account for the prior service costs that result from pension plan modifications: (a) The first alternative (the prospective method adopted in FASB Statement No. 87) requires that these costs be expensed in the current and future periods, with no liability recorded when a cost arises. (b) Under the second alternative, the total amount is recognized as an expense in the current period, and a liability is recorded. (c) Under the third alternative, retained earnings is debited with a prior period adjustment and a liability is recorded. (d) Using the fourth alternative, an intangible asset and a liability of equal amount are recorded.